5 Things To Ponder: The Central Bank Edition

This past week has been all about "anticipation." The markets made little headway during the first half of the week as traders waited in an almost breathless anticipation of the announcement from the European Central Bank. When the news was finally received, investors were initially disappointed but David Tepper stepped into the fray with his ever bullish optimism. CNBC's Kate Kelly stated:

"I just spoke briefly to David Tepper this morning who said his view has changed somewhat since last month when he spoke at a conference and said, famously, it is nervous time in the markets for a number of global macro reasons dealing with Central Banks. Now that the ECB has made this somewhat historic decision today he indicates to me that he is feeling a little bit better."

And with that simple line, the markets soared to historic highs as a massive "short squeeze" boosted stocks higher.

It is the ECB's "historic" decision that we will ponder this weekend. I have selected five different pieces of analysis with opposing views of the ECB's actions and what the potential implications may be. The ECB has clearly entered into uncharted territory on a massive scale with all other Central Banks now watching for clues to success or failure to dictate their own monetary policies going forward.

Could induce some lending as banks loosen standards to offset lost interest income

Could increase borrowing costs as banks pass own increased costs

Could feed into FX markets

"I don’t think this is a huge deal. In fact, it’s probably more experimental than anything else. The meager size of the rate cut tells me they’re toying with the policy and seeing what the near-term impact will be. The more important policy change is probably the longer term refinancing operation and the ECB’s commitment to continue providing liquidity."

"Draghi’s announcement is the most dramatic since he announced his plan to 'do whatever it takes' to save the euro in the summer of 2012. While that succeeded in keeping the bloc together, the ECB is still trying to fix its battered economy as banks in southern Europe unwind bad loans and shy away from fresh lending to businesses that could spur growth.

'Has Draghi served us a similar treat today? Not quite,' said Holger Schmieding, chief economist at Berenberg Bank in London. 'But he delivered more than the ECB had suggested before. Taken together, the innovative and comprehensive bundle of measures will support the economic recovery over time, and it certainly will not do any damage.'"

"The rate cuts prompted fury in Germany, where the head of the German Association of Savings Banks, Georg Fahrenschon, accused the ECB of expropriating savers. 'We are tearing a hole in the pensions of savers. Over time these low rates will destroy the value of assets,' he said.

Der Spiegel deemed it was the 'end of capitalism', while Die Welt described Mr. Draghi as Europe’s Bismarck, a near autocrat beyond control. It is a foretaste of what may happen if the ECB does graduate to QE later this year, once the machinery is ready.

It is an immature market in Europe, with just €700bn of assets to buy, and it is unclear whether purchases of asset-backed securities can direct much lending to small businesses, where it is most needed. It is costly to put together packages of sellable loans for family firms. “Their importance to politicians far outstrips their attractiveness to creditors,” said Matt King, from Citigroup.

In the end, the ECB may have to bite the bullet and resort to full-blown purchases of sovereign debt, just like the central banks of the US, Britain and Japan. That thorny issue has been put off for a few more months while the ECB prays for a miracle."

“'If the ECB cut the deposit rate, it would take an important profit opportunity away from banks,' said Tobias Blattner, an economist at Daiwa Capital Markets Europe in London. By doing so, the ECB would also be 'encouraging banks to lend to the real economy' even though 'there’s hardly any demand for credit,' he said. Blattner predicts the ECB will cut its benchmark and leave the deposit rate at 0.25 percent.

ECB Executive Board member Benoit Coeure said on Feb. 19 that market interest rates of zero or lower 'can result in a credit contraction.'

That’s because banks, trying to preserve their deposit bases by paying customers a reasonable interest rate, may reduce lending to companies and households because the return is too low and invest in higher-yielding assets instead."

Bringing It Home....

"Kocherlakota acknowledged that keeping rates low for so long can lead to conditions that signal financial instability, including high asset prices, volatile returns on assets, and frantic levels of merger activity as businesses and individuals strive to take advantage of low interest rates.

“In a world of rational expectations, asset prices adjust and that’s it, but if one allows for limited information, the resulting bull market may cause investors to get ‘carried away’ over time and confuse what is a one-time, perhaps transitory, shift in fundamentals for a new paradigm of rising asset prices.”

The more I read, the clearer it becomes that the world's Central Banks have become caught in a "liquidity trap" which is entirely based on circular logic. Central banks must create asset bubbles in the hopes of stimulating economic activity. When the bubble eventually pops the economic activity evaporates which requires the creation of another asset bubble.

It reminds me of Jack Black in "Envy" where he promotes his new product "Va-poo-rize." While you may appear to get rid of the "poo" for now, the question remains "where does it go?"